Electronic trading systems allow entry of a bid or offer for a particular tradable item, which in futures trading is referred to as a contract. The simplest possible futures contract is the outright contract defined by a product and a delivery period. It is also possible to define contracts that are combinations of simpler contracts. For example, the spread contract is defined as the simultaneous purchase and sale of two tradable items, such as futures contracts for different months, different commodities, or different grades of the same commodity. The bid and offer components of a spread are termed the bid leg and the offer leg respectively.
Electronic trading systems accept bids and offers in the form of orders, also referred to as real orders because they consist of data entered by traders either directly or by computing devices under their control. Real orders may be entered for any tradable item in the system. Implied orders, unlike real orders, are generated by the system on the behalf of traders who have entered real orders, generally with the purpose of increasing overall market liquidity. For example, an implied spread may be derived from two real outrights. Trading systems create the “derived” or “implied” order and display the market that results from the creation of the implied order as a market that may be traded against. If a trader enters an order to trade against this implied market, then the newly entered order and the real orders that were used to derive the implied market are executed as matched trades.
Implied orders frequently have better prices than the corresponding real orders in the same contract. This can occur when two or more traders incrementally improve their order prices in hope of attracting a trade, since combining the small improvements from two or more real orders can result in a big improvement in their combination. In general, advertising implied orders at better prices will encourage traders to enter the opposing orders to trade with them.
An electronic trading system operated by an exchange or similar business entity must provide tradable items whose definitions and properties are acceptable to traders, regulators and other relevant stakeholders. One of these properties is the minimum price increment for the contract being traded, also referred to as the contract “tick”. For example, the crude oil contract traded on the New York Mercantile Exchange is specified by the exchange to trade in increments of $0.01 per barrel and has a one-cent tick.
When a real order to buy an outright contract trades with a real order to sell an outright contract, the trading system reports the price of the trade at the price agreed to by the traders, which will normally be a multiple of the minimum price increment for the contract being traded, which may be referred to as an on-tick price.
When a real order to buy a combination contract trades with a real order to sell the same contract, the trading system records a trade for every leg of the combination. For example, a trade in the January-February crude oil spread is recorded as a trade in the January outright and a trade in the February outright. This makes it possible for the exchange to record the positions held by traders in each contract and the amounts they paid or received. The payment data is needed by the exchange to operate as a business, for example in setting margin requirements for traders.
Combination contracts include a minimum price fluctuation (i.e., tick size) as part of the contract specification. The minimum price fluctuation is not required to be the same as the tick size of one or more of the contract legs. However, in some embodiments, the minimum price fluctuation may be the same as the tick size of one or more of the contract legs. In the event that the minimum price fluctuation is the same as the tick size of one or more of the contract legs, the price of a trade in the combination may be converted into leg prices. One leg may be set to an anchor price according to a rule established by the exchange, for example, using the price of the last trade in the most recently traded leg. The other leg prices may be calculated using the anchor price plus or minus the prices of the components of the combination. Accordingly, the leg prices are automatically on-tick.
When the combination contract does not have the same tick as one or more of the legs, which can happen when the combination is a spread between products sold in different units such as gallons and barrels, then simple addition and subtraction does not automatically result in leg prices that are on-tick. In this case, the leg prices may be rounded to on-tick values so that they can be reported to the exchange. Accordingly, the spread contract may be referred to as a roundable spread.
Leg prices may be rounded to on-tick values for simple trades of roundable spreads against other roundable spreads or roundable spreads against a pair of outrights (i.e., a simple form of implied trade). Only one price rounding is typically required in these trades. The possible gains and losses from rounding are understood by the participating traders and generally accepted. However, a trading system with more complex implied markets may have tradable order combinations with any number of roundable spreads, for which a much wider distribution of gains and losses is theoretically possible.
Prior art trading systems do not have a systematic and predictable method of calculating on-tick leg prices for longer and more complex implieds. This has limited the use of implied orders in these systems.